The second oil shock in two years has wrecked the government's plan for economic recovery, which is based loosely on the structural adjustment programmes (SAPs) imposed by the International Monetary Fund on developing countries.

Under a formal SAP, a struggling poor country running a big trade deficit would offer fiscal austerity in return for favourable borrowing terms. Lower interest rates would lead to a lower exchange rate, boosting production and exports. The domestic part of the economy would be squeezed hard.

Greece and Ireland have had modern versions of SAPs imposed on them in recent months; the UK has designed its own hair-shirt policy in which a four-year deficit reduction plan is meant to keep the financial markets sweet and allow Threadneedle Street to keep money cheap.

George Osborne is wrong to say that there is no alternative to the government's plan to eliminate the "structural" part of the budget deficit in this parliament, the bit that will not go away even when the economy has fully recovered from the effects of the 2008-09 recession. Nobody knows for sure how much of the deficit is structural and how much cyclical, and there is no law of economics that says the public finances have to be repaired within a specific time period. As Ed Balls, the shadow chancellor, has noted, they are taking a much more measured approach to deficit reduction in the United States.

But the chancellor is right to argue that the problems of the UK economy pre-date the formation of the coalition last May. The importance of the financial services sector meant Britain was bound to have a particularly nasty recession when the banks started to go belly-up. Labour did nothing during its 13 years in power to counter the growing stranglehold over the economy exerted by the City since the Big Bang reforms of 1986.

Unreformed

Mervyn King warned at the weekend that another financial crisis is brewing. The financial sector remains unreformed, and many of the practices evident in the bubble years – such as speculation in high-yielding but risky investments – are back. Predictably, the Bank of England governor's comments were greeted with the usual riposte from the City: we are a centre of excellence for the UK but highly mobile. If you mess with us, we'll up sticks and leave the country.

At this point, ministers normally back off. They do a rapid audit of the British economy and note that there is not much to it apart from a booming financial services sector, a bloated housing market (currently in the doldrums), a large public sector about to be pared back and the residue of an industrial base in which only two sectors – pharma and defence – could remotely be considered global players. Taking action that may hinder the expansion of one of the country's few centres of excellence seems far too big a gamble. It will be a brave chancellor who heeds King's warnings and ensures that the banks are no longer "too big to fail".

Yet a failure to act will mean that there will be no let-up in the boom-bust cycles that have bedevilled Britain for the past 40 years, and the deep structural problems in the economy will go unresolved. Two perspectives from the developing world may help explain why this is so.

The first is a phenomenon known as Dutch disease, in which a country discovers it has bountiful supplies of a natural resource, such as oil or diamonds. The name comes from the experience of the Netherlands, after it found a huge gasfield in the 1950s. At first, the windfall is seen as a great boon, a way to boost growth and generate employment. But eventually the discovery is seen as a curse, because it leads to hot money flooding into the country, an increase in the value of the currency and a decline in manufacturing.

Under the last Labour government, the City was a virulent form of Dutch disease. London, as one of the world's main financial centres, attracted investment funds from all over the world. Hot money flows led to a higher exchange rate, which crippled manufacturing. The stronger pound also kept the lid on inflation and kept interest rates low, creating the conditions for excessive personal borrowing and an asset-price spiral. When the bubble inevitably burst there was a big mess to clear up.

This is a familiar pattern for the UK. There are periods – the late 1970s and the mid-1990s – when in the aftermath of a crash, stringent fiscal policy is used to rebalance the economy towards exports and manufacturing, but history suggests that they don't last for long. Sooner or later the credit tap is turned back on and another cycle begins, with the imbalances in the economy – between the City and manufacturing and between London and the rest of the UK – even more pronounced.

Disease

King's plan to break up the banks would be a start in curing Britain's Dutch disease. But there is also a case for the Bank, in its new role as the City's watchdog, to be given tools that would allow it to discriminate between lending for productive purposes and lending for speculation. If the government was serious about rebalancing the economy, it would keep control of the banks taken into public ownership and use them to invest in sectors of the economy seen as important for the future.

This is where the second lesson from the developing world applies. Imagine for a moment Britain, not as a developed nation, but as the equivalent of Japan in the 1950s or Taiwan in the 1970s. A developing nation, in the UK's position, would decide which sectors it was going to specialise in and then provide them with all the support it could muster. The banking system would be the servant of industry, not its master, and there would be an industrial policy that protected fledgling industries in their early years of development.